I commonly see many people overvaluing their retirement number or honestly, and more commonly, not having even a ball park idea of where their retirement number really is.
I get it, as a 20, 30, or even 40 year old worker, retirement is so distant why even worry about it. Go to work, eat, sleep, repeat. Maybe mix in a drink or 10 to deal with the stress and monotony of this routine. It’s hard, and living in the moment is easier than facing this far fetched concept that is retirement.
However, this number may be much closer than you think and calculating your number might motivate you to make some small decisions/changes in your life to get there even quicker.
Why wait until you are 50 before you sit down with an overpaid financial adviser after 25 years of working/saving for retirement without a plan in place only for the adviser to tell you you can’t retire for another 15-20 years.
Wouldn’t creating your own plan, for free, right now with some simple but research backed math be easier?
I Don’t Want to Quit Working
I understand that many people may want to keep working past their retirement number because they love what they do, want to live lavishly in retirement, want to leave a nest egg for their loved ones or want to get into philanthropy.
So to address this right away, this isn’t a conversation about wanting to work or not, it’s purely a conversation about when you could safely retire. And what your number is.
I don’t care if you work forever. That’s fine. Even if that is the case, reaching your retirement number gives you what Jim Collins calls FU money. It’s the kind of money that says I work because I want to, not because I have to.
It’s the kind of money that makes your boss rethink who’s desk he is going to place the stack of work on. You, the person who could walk away at any point from your job or Brad the guy who just bought a brand new Tesla so that he could be the “Tesla guy” at the office. The same guy who now who needs this job to cover the ridiculous monthly payments?
Remember, jobs change, coworkers change, bosses change, your family changes, and you change. What once may have been the perfect job that you couldn’t see ever quitting might not be that same job in 10, 15, 20 years from now.
Just food for thought, anyways, so when can I retire?
The 4% Rule or the 4% Safe Withdrawal Rate
What is It?
The rule states that you can spend 4% of your retirement account per year and still be able to retire safely.
For example: If you have 1 million dollars in your retirement account when you retire. The 4% rule states that you can safely spend around $40,000 per year during your retirement years without running out of money.
I prefer using the reverse 4% rule because this then let’s us calculate when we can safely retire based on our normal annual spending rate.
Reverse 4% rule: Take your annual spending and multiply it by 25. This now gives you a retirement number you can aim for. Rather than blindly saving, this gives you an objective target to aim for. Some direction for your savings.
So if individually you spend $50,000 per year you then need to save $1,250,000 before you could retire. Or if as a couple/family you spend $70,000 per year, you’d need $1,750,000 before you could safely retire. But you would also have dual income at this point in some circumstances.
What’s nice about this equation is that it is backed with research which is what I’ll discuss with you further below. But more importantly, it blatantly hits you in the face, that if you can live off less per year that your retirement number decreases.
So instead of placing the blame of why we can’t retire yet primarily on our income like most of us do, it places it on something we can control: our annual spending. Which now makes it that much more important now to keep tract of your spending every year.
It sucks to look back at the stupid stuff we bought each year but it’s an important exercise to do for ourselves and for our relationships. You don’t even have to change anything, but understanding where your money goes is really important.
Often times it shows us a subscription tp HBO GO that we forgot to cancel after GOT ended, a magazine subscription we aren’t even receiving at our current address anymore, or gym membership we don’t use.
Point of the story is, we spend money on stupid shit every year. Take the time to recognize this and small changes in spending tend to take place even if you don’t plan on it.
Anyways, let’s nerd out.
The Research
I’m nerdy and skeptical, so I needed to see the numbers to prove that this actually works before I’ll blindly follow any rule.
And to be honest, rule is a strong word choice anyways. Guideline or rule of thumb is probably more fitting. Since few people get to their exact number and quit the day of.
Although, the math says you could.
The Trinity Study
So this equation was first studied in a paper coined “The Trinity Study” that was released in 1998 at Trinity University in Texas.
Basically this study looked at success rates of multiple portfolios comparing the different asset allocations and different withdrawal rates from 3%-12% over the period of 1925 to 1995.
Though many people have continued this study to to show continued accuracy to the present time. So we will look at the study from 1925 to 2018.
I get that’s a confusing paragraph if finances/investing aren’t your primary language so let’s break it down.
Asset allocation: is the percentage of what a portfolio is a made up of I.e stocks, bonds, and cash/equivalents.
Withdrawal Rates: As mentioned above, is the percentage of a portfolio that a retiree plans to take out each year to live off of
Below is a graph that I really like that shows the results of this study.
Key Points
- The success rate is 100% with a 4% safe withdrawal rate with an asset allocation of 75% stocks over a 30 year retirement. Meaning that whatever year you started your retirement during this period, 100% of the time, you didn’t run out of money which equates to a successful retirement.
- A allocation of 75% stock and 25% bonds is optimal when paired with a 4% withdrawal rate over a 30 year period.
- If we lowered our withdrawal rate to 3%, success is guaranteed with any asset allocation.
Doom and Gloom: Worst Case Scenarios
What this data also tells us is that even if you retired during the great depression, the 2000’s tech crash, or the 2008 financial crisis, the 4% rule was still successful.
Those people who retired the exact day that the market crashed, still had a successful retirement. Let that sink in… So the odds of us being able to retire in more than likely a very normal retirement landscape make the success rate that much higher.
What would it take for this rule to fail?
According to Kitces research over at Kitces.com on safe withdrawal rates, basically the stock market would have to remain flat for 27 years for the safe withdrawal rate to fail for recent retirees.
Remember, every crash in the history of all stock market crashes has recovered and recovered to the point of new all time highs.
Crashes are scary but even these economic events don’t break the safe withdrawal 4% rule. And if you are still nervous, no one says you can’t adjust your saving to a 3% rule which basically guarantees you will be successful in retirement.
Obviously, I would be remiss not to mention that past returns are not indicative of future results.
However, I’ll side with history on this one. If the stock market has continued to rise through depressions, wars, and political changes, an event that would change this trajectory would likely be catastrophic.
Meaning most of us would have bigger issues than our retirement plans anyways.
I don’t want to die as I spend my last dollar!!!
I feel that most people still view their retirement money and retirement age as the day their money officially runs out.
You roll up to the vending machine in your wheelchair at the retirement home, you put your last dollar in to buy a Snickers and boom, you start seeing the bright lights.
Not true.
And whether you like it or not, you are likely going to be left over with a large nest egg for your spouse or heirs. Or to donate to whatever you want.
Again, according to Kitces, over 2/3rds of retirees finish their 30 year retirement period with over double their starting principle. And only 4 years over the period of this entire study from 1925, did retirees finish with less than 100% of their starting principle.
Meaning throughout the course of retirement, depending on your given retirement year, most people can actually ramp up from their 4% safe withdrawal rate if they so choose.
Early Retirees
However, for most of us on this journey towards financial independence. We don’t plan on only being retired for just 30 years.
If I retire by 35 to 40 like I plan, I really hope I live past 70. So we need to see how this math works for longer retirement periods such as 40, 50, or even 60 year retirement periods. And with modern medicine who even knows any more.
Below is a graph from Early Retirement Now that maps out the results of this study with longer retirement periods.
Key Points
- You can see that a 4% success rate breaks down a little bit to an 88% success rate with a 4% safe withdrawal rate and 75% stock allocation over a 50 year period.
- 3.5% appears to be the optimal safe withdrawal rate to maximize success with 75% stock allocation
- The argument can be made that 100% stocks might begin to edge out 75% stocks if you could handle the volatility.
Overall, with longer retirement times, the 4% safe withdrawal rate continues to hold up with success rates that I am comfortable with because I am flexible.
Remember…
Retirement Isn’t Set in Stone
Most of us want a 100% sure thing, but if someone gave me a 93% chance to successfully be able to retire. I am going to take those odds every time versus working another 1-2 years when I don’t have to.
And remember, we plan to be early retirees, nothing says that we can’t work again in the future, work part time or pursue a life long career/hobby that may net some income.
The safe withdrawal equation is created assuming the retiree will never have income again. It negates the fact that most of us in one way or another will generate some form of income.
In fact, this equation doesn’t even account for social security. Which is how I recommend everyone to plan for retirement just in case. But still, the odds are good that something will be left over in social security when our generation becomes of age. And if so, this would then further work the equation in our favor further ensuring success.
Even something like an inheritance from a parent/relative, downsizing one’s house, or moving to a lower cost of living area would significantly change the outcome of this equation.
Nothing is set in stone
Early Retirement Allows for an Aggressive Retirement Plan
And because nothing is set in stone, when I retire, I’ll be young, likely will have a side income, and will still be very employable, it will allow me to take on even more risk with my investing.
Meaning, I can continue to expose my portfolio to 100% stocks to further maximize my portfolio growth in retirement and further leave a legacy for my family.
Because I know that I can always decrease my cost of living or return to work if the stock market crashes so I can avoid major sequence of return risk by selling stock shares when the market is low.
Basically meaning, I’m using my employability and flexibility as the bonds of my portfolio to maximize it’s growth in a potential down market.
Conclusion
- The 4% rule works in the majority of cases as a retirement number to aim for even during monumental economic downturns.
- To calculate your retirement number, multiply your yearly expenses or the expenses you plan to live on during retirement and multiply by 25. This is your retirement number.
- If you are conservative or plan to be retired for 40+ years, a 3.5% safe withdrawal rate will be even safer.
- The math says the majority of people will maintain all if not more of their initial principle in the end.
- There are no hard rules to retirement. You are allowed to be flexible in retirement, work if you want to, and likely spend more then you think you can as a result.
As my Grandpa always said, you can’t take it with you.
Why not calculate your number now and start making a plan to work towards it today, because why sell your time another day then you have to. Why not buy yourself the freedom to spend your time exactly how you want to.
I realize that this post had a lot to unpack in it and might be confusing at times, if you have any questions please comment below or message me here.
